The mood coming out of the annual shopping center convention in Las Vegas last month was decidedly upbeat and cautiously optimistic. There is a feeling building that we have begun to turn the corner in retail real estate. As one attendee commented, “We are no longer looking into an abyss.”
There are still many hurdles to climb. While the unemployment rate across the nation and in Indiana shows signs of topping, it is still at a historically high rate of about 10%. Retail occupancy and rents are still well below previous levels and will likely remain so for the next 18-24 months. However, the increase in retail and restaurant activity is likely to pay benefits in 3Q and 4Q 2010 as more leases are signed and more store openings are emerging on the horizon. Fortunately, new development is at a virtual standstill and will remain so for the foreseeable future. We are yet not in need of new space because there is plenty of work to do leasing vacant space and helping our clients start new businesses. Today’s increased activity levels give us a bit more confidence going into the second half of the year.
Retail and restaurant expansion plans are perking up for the first time in two years.
The National Restaurant Association is reporting that its Restaurant Performance Index (RPI) index rose to its highest level in 27 months in February and capital expenditures and expansion plans are also in the rise. Given that we have lost more than 280,000 eating and drinking place jobs during the recession, and an untold number of restaurant locations, this is a welcome sign for the industry (read the full press release).
At the same time, Retail Lease Trac is reporting an increase in projected store openings for the first time in a year. Their tracking of 2,000 leading retail companies indicates plans to open over 65,000 stores in the next 24 months.
All of this bodes well for net lease investment which is leading the charge as one of the few bright spots on the commercial real estate horizon. Many restaurants and a large number of expanding retailers are single tenant entities and often look to investors as landlords and to assist with their expansion plans. Net lease investments have long had the attraction of very limited property management duties and maintenance compared to other real estate investments. In addition,with banks paying a paltry .25% on money market accounts, the opportunity to receive an 8% or better return on that same cash, and limit investment risk, is a compelling opportunity in current environment.
Here’s a tale of excitement and shoppers flocking to get the goods and services they want amidst this retailing climate plagued by gloom and doom.
Providence Town Center is a “power town” shopping center that recently opened in Collegeville, PA – a Philadelphia suburb. The project is intended to be a hybrid power center/lifestyle center. A 132,000 sq. ft. Wegman’s opened on Sunday to a throng of shoppers, including 1,500 who lined up at the door at 7AM. (Wegman’s is a good story in and of itself. They are quite well known in the mid-Atlantic for high quality stores and a loyal customer following.) The twist is this particular Wegman’s includes The Pub, a full-service restaurant located inside the store’s Market Café.
The enthusiasm and excitement of the shoppers is a bright spot and a testament to delivering what the people want and where they want it.
Providence Town Center also includes Best Buy, LA Fitness, Dick’s Sporting Goods, DSW Shoes, Ulta Cosmetics, Five Below, Staples, PetsMart, Michaels’, Raymour & Flanigan, PNC Bank, PF Chang’s, Eastern Mountain Sport (EMS), and Olive Garden. This is one of the larger retail projects to open this year (about 500,000 sq. ft.). Private developer Brandolini Companies also envisions a lifestyle center as part of the project in the future, adding another 200,000 sq. ft. or so. As one might expect, this component has been delayed for the time being. I have seen many hybrid centers around the country but few with full-line grocery stores. Power center developers, take note.
The reality is that we do have too much space for the given market conditions. Too much or too little space is relative to the demand for this space.
The demand for retail space is highly correlated to population/population growth and income levels. In this decade the industry built retail space that took the per capita shopping center square footage from 21 in 2000 to 23.5 today. This is a compound annual growth rate of 1.3%. Given that, the population was growing at about 1% per year in the U.S. and income/wealth was also growing, this seems appropriate on the surface. However, in the current economy, incomes and wealth are down substantially and we have lost most of the jobs created in this decade. We are now over-stored and retail stores are closing and many shopping centers are in distress as a result. The supply of space now far exceeds demand. Roughly half of the space that was built in this decade was off-mall, big box. We are seeing the direct fallout from this trend with the bankruptcies of Circuit City and Linens ‘N Things and store closings by other box retailers.
Virtually no enclosed malls were built in this decade. Enclosed malls are facing another challenge and that is the slow grinding obsolescence of the department store format–which is largely responsible for decline of some regional malls and the related emergence of the so-called lifestyle center (essentially an open-air mall without department stores). Good quality A & B malls are holding their own in the current environment and will continue to do so. However, poorer quality malls are being impacted across several fronts: by quality malls they compete with, as well as all other formats from off-mall boxes, to lifestyle centers to internet retail. This trend will continue and many C & D malls are going to slowly die as a result of this trend. Retail contraction is underway and it is largely the result of decreased demand. Overactive lending did not help and created some poorly underwritten shopping centers that should not have been built. Regardless, supply now far exceeds demand and this is going to take several years to work itself out.
There is a lot of talk about rent relief and rent concessions in the current environment and how this is impacting shopping center landlords and publicly traded REITs. Hardly a day goes by without another article or news report talking about retail tenants asking for and in some cases getting rent relief. Is this happening? In fact it is happening. It is completely a function of the local market situation, the particular tenant and the level of pain for the landlord (or lender in some cases). Is it widespread? No, it is not. Some landlords who are strapped themselves are telling tenants to pound salt. While retail sales are down almost everywhere, quality shopping centers and malls won’t even consider rent relief. Consider a typical A class mall with pre-recession sales of $500 PSF. If sales are down 10% right now from peak to trough, the average sales $PSF is still $450 and tenants are absorbing some of the resulting higher occupancy costs and also dealing with it by cutting expenses. There was a great deal of “fat” that built up for landlords and tenants alike in this decade and much of it has now been trimmed off. If sales drop precipitously from this point, we are going to have a problem, but the economic and retail signs are pointing towards a bottoming out and leveling off.
Rent relief is taking several different forms:
Early renewal at the existing rent or in some cases even a slightly lower rent, to lock in the rate for the tenant and get more term for the landlord (a popular strategy with private companies with little access to capital themselves).
Rent deferral – reducing current rent but backloading it onto the end of the lease (a popular strategy with publicly traded REITs). While this reduces cash flow in the present, it attempts to preserve the income stream over the life of the lease.
Reduced rent in exchange for little or no tenant allowance. Landlords are willing to exchange rent for tenant improvement dollars and this is happening in some instances. However, the tenant needs to then be in a position to fund their own store build out and this does not work for many tenants because of credit availability – especially mom and pop’s in the current environment.
Asking rents are simply down, almost universally and especially in the off-mall environment. There are some tenants active in new store development that are getting rent relief in the form of reduced market rents and landlords are willing to do deals at ~25% less (than peak rents) in some cases for the right situation.
Move down the road. Anecdotally, I have seen some tenants move down the road from their existing location and get “rent relief” by simply dealing with a more aggressive landlord in another shopping center.
Rent relief is going to be with us for some time and it will continue to be a renters market in the foreseeable future . Tenants with a smaller footprint have the best opportunity to exploit the current market by significantly reducing their occupancy costs in new store locations. Existing leases are best reduced when the end of term is close at hand.
